ICRA has given a stable outlook for the Oil and Gas sector, in its year end assessment of the Indian Corporate Sector. The domestic demand for petroleum products grew at a tepid rate of 1.0% in 7M FY2020 vis-à-vis 7M FY2019 due to economic slump and erratic rainfall patterns. Given the weak outlook for several end users, the demand growth is expected to remain in the range of 1.0-3.0% in FY2020 and FY2021.
As for the Upstream sector, even though the production of crude oil has declined by 6.0% in H1 FY2020 vis-à-vis H1 FY2019, the production of oil is estimated to grow in FY2021 over FY2020, primarily due to ONGC commercializing some of its fields and Vedanta increasing production from its Rajasthan asset. ICRA notes that the partial recovery in crude oil prices from the lows of 2016 continue to incentivize exploration and development activity leading to increase in capital budgets especially of private companies. Gas production which has declined marginally in H1 FY2020 vis-à-vis H1 FY2019 is expected to grow in FY2021 owing to commencement of production from RIL-BP KG D6 field while the ramp up of production from KG basin field of ONGC is expected to commence production in December 2019. However, any large debt funded overseas acquisitions will be a key monitorable.
The capacity utilization of refineries is expected to remain higher in FY2021 vis-a-vis FY2020 owing to shutdowns across refineries for BS-VI fuel specs upgrades, supressing the utilisations in the latter period. GRMs of refiners have weakened considerably in H1 FY2020 due to compression in light-heavy crude spreads, brought about by supply glut in light-sweet crudes and voluntary supply cut of heavy crude by OPEC+ allies. Higher processing of light crudes also resulted in excess supply of light & middle distillates, pulling down their crack spreads. Notwithstanding the current weakness in crack spreads, the outlook for GRMs is expected to improve owing to the uplift in gasoil cracks expected with the implementation of stricter IMO regulations for bunker fuel from January 1, 2020. Also, the GoI's planned divestment of BPCL would be a key monitorable to determine the future competitive dynamics in the sector. Notwithstanding the divestment, PSU companies are expected to declare hefty dividends for FY2020 owing to the poor fiscal position of the GoI.
ICRA expects increasing shale oil production in the US and US-China trade war worries to weigh on the price of crude oil. However, OPEC and Russia's increasingly active management of supply through production cuts is expected to keep the prices of crude oil elevated. Accordingly barring any geo-political shocks, prices of crude oil should hover in the region of $55/bbl-$75/bbl and accordingly the under recoveries on sensitive products viz. SKO and domestic LPG are expected to be entirely borne by the GoI. However, the OMCs may be directed by the GoI to curtail a part of their marketing margins on the sale of auto fuels at the upper end of the aforementioned range. Nonetheless credit profile of the E&P and R&M companies should remain stable given the headroom in key credit metrics.
ICRA expects the consumption of natural gas to grow at a healthy rate in FY2020 and FY2021 owing to increasing coverage of CGD networks with a strong emphasis on expansion of PNG(d) coverage and start-up of new fertilizer plants. The start-up of several new LNG terminals and increasing pipeline coverage would be a key enabler in natural gas consumption growth. However, start-up of several LNG terminals within a short span amid increasing domestic gas production is expected to challenge the ability of new terminals to achieve high capacity utilisations and achieve meaningful returns in the initial few years. Additionally, some of the new pipelines are also expected to be sub-optimally utilized in the initial years owing to lack of adequate volumes.
Owing to increasing gas consumption and increase in tariffs by the regulator for several key pipelines, ICRA expects the outlook for pipeline transmission companies to remain healthy. Additionally, though the regulator is considering the adoption of an entry-exit model for transmission tariff, the adoption of the same remains to be seen in FY2021. Nonetheless, significant divergence in spot and term LNG prices could put some pressure on the marketing margins of gas marketers.
ICRA expects the outlook for City Gas Distribution (CGD) entities to remain stable on the back of GoI's push for increasing penetration of CGD networks and provision of domestic gas for the CNG and PNG(d) segments. However, some of the entities that have won a large number of GAs in the 9th and 10th round of bidding will be exposed to increasing project execution risks as the statutory approval processes are protracted which could lead to potential delays in execution. Additionally, PNGRB has formulated a concept paper for tariff determination for third party entry in certain pre-existing CGD networks, implementation of which is beset with several challenges. Even if all the challenges are overcome and third party access is a reality, it is estimated that the profitability of the incumbents will not be affected materially in the old GAs, as network margin will be protected.